Thoughts on the Market: Special Encore - Housing and Currency Markets in Focus
Hosted by Morgan Stanley
Episode Overview
In this special encore episode of "Thoughts on the Market," Morgan Stanley delves deep into the pivotal sectors shaping the global economy as we transition into 2025. Hosted by Vishi Tirupator, the Chief Fixed Income Strategist at Morgan Stanley, the discussion brings together key strategists to explore the future of government bonds, currency markets, and the housing sector. Participants include Matt Hornbach (Chief Macro Strategist), James Lord (Global Head of Currency and Emerging Market Strategy), Jay Bachhow, and Jim Egan (Co-Heads of Securitized Product Strategy).
1. Global Government Bond Yields Outlook
Speaker: Matt Hornbach
Matt Hornbach opens the discussion by analyzing the significant shifts in government bond yields experienced throughout 2024. He highlights the transition from a deeply inverted US Yield Curve at the year's start to a much steeper curve by year's end. This movement reflects the market's navigation through various economic landing scenarios—hard, soft, and none.
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Policy Rate Projections: Hornbach emphasizes that with the US election outcomes, global rate markets will align with the resultant policies. "Central banks around the world continue to lower policy rates in our Economist baseline projection, with much lower policy rates taking hold in their hard landing scenario versus higher rates in their scenarios for RE acceleration" (01:53).
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Yield Forecasts: He forecasts that 10-year Treasury yields will dip to 3.34% by mid-2025, ending the year slightly above 3.5%. This projection accounts for 75 basis points of Fed rate cuts anticipated beyond current market expectations.
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Inflation Expectations: Hornbach notes a tightening in breakeven inflation rates, expecting the 5 and 10-year breakevens to reach 2.55% and 2.4%, respectively, by the end of 2025, influenced by tariff implementations under the Trump administration.
2. Currency Markets: Impact of Policy Changes
Speaker: James Lord
James Lord shifts the focus to currency markets, particularly the US dollar's performance amidst the incoming administration's policies.
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Dollar Strength: Lord observes that "the dollar rally continues for a little bit longer as markets price in a higher likelihood of tariffs being implemented against trading partners" (04:10). However, he cautions that this strength may not be sustained throughout 2025 due to potential deficit expansions.
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Emerging Markets Divergence: Highlighting differences within Emerging Markets (EM), Lord points out the Renminbi as the weakest currency in their 2025 forecasts, primarily due to anticipated tariffs against China. He forecasts the Dollar Renminbi pair to end next year at 7.6, indicating a significant divergence from Dollar Yen and broader US Dollar Index (DXY) movements.
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Regional Performance: The rest of Asia is expected to track the Dollar Renminbi closely, leading to underperformance in AXJ currencies compared to CMIA and Latin American currencies, which are projected to fare slightly better.
3. Mortgage Markets and Securitized Credit
Speakers: Jay Bachhow and Jim Egan
Jay Bachhow provides an in-depth analysis of the mortgage market, emphasizing the stabilization of mortgage spreads and the anticipated trends for 2025.
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Mortgage Spreads: Bachhow notes that mortgage spreads are aligning with long-term averages, attributing this to the Federal Reserve reducing its mortgage holdings. "When they end QT, we expect mortgage runoff to continue to go into Treasuries" (06:08).
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Bank Demand Shifts: Anticipates a shift in bank demand functions, driven by potential alterations in Basel III regulations, which could free up capital and reduce regulatory uncertainties. This change is expected to enhance mortgage funding and tighten spreads.
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Foreign Investment: He forecasts increased demand from overseas investors, particularly Japanese life insurance companies hedging FX risks as the Fed cuts rates and the Bank of Japan hikes.
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Agency CMBS: Bachhow highlights the potential for tighter spreads in agency Commercial Mortgage-Backed Securities (CMBS) due to constrained supply and favorable Fed policies.
Jim Egan complements this analysis by discussing the broader implications for the US housing market:
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Housing Affordability: Egan outlines that while mortgage rates have increased since September, they remain 100 basis points lower than in late 2023. This trend, coupled with decreasing 10-year Treasury yields, is expected to improve housing affordability in 2025.
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Sales Volumes: Although sales volumes have been stagnant, with a 3% year-to-date decline, Egan anticipates a rebound as affordability improves, predicting over 5% growth in new home sales despite the "lock-in effect."
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Securitized Credit Opportunities: Egan expresses optimism for securitized credit, citing opportunities in CLO AAA tranches, non-QM AAAs, agency MBS, and CMBS, which offer attractive value amidst a flattened capital structure.
4. US Housing Market Outlook
Host Commentary
The host summarizes the housing market's trajectory:
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Affordability Improvements: Expected to enhance over 2025 due to declining mortgage rates and increased 10-year Treasury yields.
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Sales Volume Recovery: With the easing of mortgage rates, sales volumes are poised to pick up, entering a "sweet spot" despite historical low supply levels.
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Market Stability: The housing market is underpinned by strong credit standards and limited supply, providing a resilient foundation with only modest challenges anticipated ahead.
Conclusion and Future Outlook
As the panel wraps up, the consensus is cautiously optimistic about the interplay between declining government bond yields, fluctuating currency markets, and stabilizing housing conditions. While uncertainties remain—particularly regarding policy changes and their broader economic impacts—the strategies discussed provide a roadmap for navigating the financial landscapes of 2025.
Notable Quotes:
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Matt Hornbach: "Central banks around the world continue to lower policy rates in our Economist baseline projection... leading to lower government bond yields and steeper yield curves across most of the G10 through next year." (01:53)
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James Lord: "The dollar rally continues for a little bit longer as markets price in a higher likelihood of tariffs being implemented against trading partners." (04:10)
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Jay Bachhow: "We expect more demand from Japanese life insurance companies... to add agency CMBS in a way that they haven't really been adding in the last few years." (06:08)
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Jim Egan: "We have a negative 2% HPA call next year. Not significantly down... we don't think there's a lot of room to the downside given the healthy foundation." (08:35)
Stay Informed
For those who missed this insightful episode, "Thoughts on the Market" offers a comprehensive analysis of the forces shaping our financial world. Stay tuned for more expert discussions and market perspectives from Morgan Stanley.
Disclaimer: The insights provided in this summary are based on the content of the podcast episode as of December 26, 2024. They are intended for informational purposes only and should not be construed as financial advice.
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